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Development of regulatory powers of the SEC

Section 6(b) would amend section 15(b) of the Exchange Act in several major respects.

The necessity for proving the use of the mails, or other similar Federal instrumentalities, in connection with violations by brokers or dealers of the various sections of the act, would be eliminated. The special study concluded that this jurisdictional requirement has impeded prosecutions under the act in the past simply because the task of proving use of the mails was too laborious or impractical. It felt that the broker or dealer voluntarily subjects himself to Federal jurisdiction by registering with the Commission.

The bases for disqualification of brokers and dealers would be broadened. The statutory bars now contained in section 15(b) of the Exchange Act are limited. For example, disciplinary sanctions imposed by the national securities exchanges, or the NASD, even though resulting from misconduct involving securities transactions, are not a basis for refusal of registration by the Commission. Conviction of certain crimes, such as embezzlement and fraud, unrelated to securities, are not disqualifications under the statute. Willful aiding and abetting does not prevent registration as a broker or dealer. These and other past activities of individuals may indicate as much potential danger to the investing public as the securities offenses now listed in section 15(b). Accordingly, the Commission has proposed that the present list of bases for disqualification be expanded. It should be noted that many of the new grounds for disqualification are already found in the Investment Advisor's Act, and to this extent the amendments would merely make the two acts consistent.

Other new disqualifying grounds have been proposed to fit the needs disclosed by the special study. Included in this list is a disqualification based on an individual's negligent supervision of employees resulting in a violation of the Federal securities acts. Under this provision, however, no person would be deemed to have negligently supervised his employees if he had established reasonable procedures to prevent and detect unlawful practices and if he reasonably discharged the duties and obligations incumbent upon him by reason of such procedures. The exchange believes that the fiduciary nature of the securities business makes it just as important to screen out undesirable persons prior to the time they enter the securities business as it is to supervise carefully their conduct once they are admitted to the business. Accordingly, the exchange favors the adoption of these amendments.

A third amendment to section 15 (b) of the Exchange Act would enable the Commission to proceed directly against individuals associated with brokers and dealers, as well as brokers and dealers themselves. The SEC now has no direct power over individuals except by proceeding against the entire firm with which the individuals are associated and by naming those individuals as a 'cause in the proceeding against the firm. The special study concluded that this "shotgun" approach is cumbersome and inadequate. Furthermore, the SEC has no direct power to suspend or bar persons from being associated with brokers and dealers. In recognition of these structural weaknesses in the existing laws, the proposed amendments would grant the SEC the power to proceed directly against individuals who are associated with broker-dealer firms. The exchange believes that these amendments are necessary in the public interest and consistent with the concept of self-regulation.

Suspension of trading in the over-the-counter market

Section 6(c) of the bill would amend section 15 (c) of the Exchange Act by authorizing the Commission to suspend summarily over-the-counter trading in any security for a 10-day period when the public interest and the protection of investors so requires. This amendment would give the Commission the same powers with respect to securities traded over the counter that it now has over securities traded on an exchange under section 19 (a) (4) of the act. Past experience under section 19 (a)(4) indicates that the power to suspend trading is an effective restraint on violations of the Federal Securities Acts. The amendment would complement the expanded coverage of the proposed section 12(g). Accordingly, this amendment would be a logical extension of established policy.

Development of regulatory powers of the NASD

Section 7 of the bill would amend, in several respects, section 15A of the Exchange Act dealing with registration of national securities associations. First, statutory responsibility would be given to the NASD for the establishment of appropriate standards relating to training and experience for members and, for the first time, employees. There would also be standards relating to the capital requirements of members. The exchange believes these amendments are consistent with the policy of supervised self-regulation by the securities industry. Accordingly, the exchange favors these amendments.

Several proposals would clarify and expand the jurisdictional authority of the NASD or other national securities associations over individuals not registered with them but who are associated with their members.

Further proposals would amend the provisions dealing with Commission review of NASD disciplinary action. In particular, the amendments would shorten the time for appealing such disciplinary actions from 60 to 30 days. In addition, an appeal from NASD disciplinary action would not automatically stay the judgment of the NASD if the Commission found that a stay would not be in the public interest.

The Commission believes that justice and the protection of investors often require immediate effective action to prevent further wrongdoings. It also believes that the present awkward appellate mechanism often prevents such immediate and effective action. Accordingly, it feels that this amendment should be adopted, and the exchange feels there is merit in the proposal.

MODIFICATIONS OF PROSPECTUS DELIVERY REQUIREMENTS

In order to assure the adequate dissemination of information about companies which raise capital through a registered public offering, section 4(1) of the Securities Act of 1933 requires each broker and dealer effecting transactions in newly registered securities to deliver a prospectus to each purchaser within the 40-day period following commencement of the offering.

It is generally felt that the provision has helped to make the basic disclosure philosophy of the Securities Act of 1933 more effective. However, the climate of speculation which prevailed in the late 1950's and early 1960's gave rise to new problems, particularly the "hot issue" phenomenon, which emphasized certain inadequacies in the 40-day prospectus delivery requirement. The special study found that many factors, such as irresponsible publicity, unreasonable delays in deliveries of securities, and even the failure of brokers and dealers to deliver the prospectus during after-market trading, greatly inflamed this "hot issue" phenomenon. As a result, the special study and the Commission have recommended that the 40-day period be extended to 90 days in cases involving a company's first registered offering of securities to the public. The Commission reasons that this longer period of time is a more realistic appraisal of the period during which the distribution process continues in the case of a new issue. The exchange supports the extension of time in the hope that it will help meet the "hot issue" problem.

The Commission also has recognized that the present 40-day period may have little practical value in connection with offerings of additional securities of an outstanding class, especially if the issuer is making adequate disclosure with respect to the securities already outstanding. Accordingly, the Commission has recommended that it be granted the power to reduce the present 40-day period where appropriate, in the case of companies for which a reservoir of public information exists. The exchange strongly supports this amendment, which it feels is both practical and realistic.

CONCLUSION

S. 1642 represents a major step toward equal protection for all investors under the Federal securities laws. We urge prompt adoption of this bill in the public interest.

Senator WILLIAMS. And now from the midlands of our Nation, Mr. James E. Day, president of the Midwest Stock Exchange. Mr. Day, we are highly honored to have you with us. We appreciate your coming to Washington to be part of these interesting, perhaps historic, proceedings. We would like to have you proceed in any way that you wish.

STATEMENT OF JAMES E. DAY, PRESIDENT, MIDWEST STOCK EXCHANGE; ACCOMPANIED BY JOHN G. WEITHERS, SECRETARY, AND JOSEPH N. MORENCY, JR., COUNSEL

Mr. DAY. Thank you, Mr. Chairman. I have with me the secretary of the exchange, John Weithers, on my left. Our legal counsel is Mr. Joseph Morency, on my right.

I would like to ask that the statement I have already submitted here be made a matter of record in view of the fact that we have had many fine witnesses who have covered this bill in detail and, particularly, favorably.

I would like to brief my statement by simply saying that we think that the SEC study group have proved the need for this bill, and we are wholeheartedly for this legislation. That would be my brief.

Senator WILLIAMS. That is right to the point. I was just reading your prepared statement to get a better understanding of the Midwest Exchange. How does your exchange compare in terms of membership with the American Exchange?

Mr. DAY. They are larger than we are, unfortunately for us, both in volume and in membership. We have some 400 memberships. I frankly must confess I would have to ask Mr. Etherington how many he has now, since he has been issuing some new ones.

Senator WILLIAMS. Do you have, as Mr. Funston testified for the New York Stock Exchange, companies which are approaching eligibility for listing?

Mr. DAY. In relation particularly to this bill you are referring to? Senator WILLIAMS. Yes.

Mr. DAY. Well, I would say I appreciate Mr. Funston's statement that this could be helpful to us, with which I certainly agree, because in removing a double standard you are in a better position to compete. But our standards are, for all practical purposes, identical with New York's, and we would have a very limited number of these available or eligible for listing on our exchange.

Senator WILLIAMS. I see that you have been part of the very thorough process of discussion with the Commission in the development of this legislation.

Mr. DAY. In that regard I would say that particularly in reference to Senator Javit's remarks that it was very interesting that here was industry agreeing almost entirely unanimously with the Government bureau proposal. I do not think that just happened. I would like to go on record by saying that I think the main result of such a condition is due to the fact that Chairman Cary and every Commissioner gave the various segments of this industry a real opportunity to talk about the proposed draft in a rolled-up-sleeve, coats-off session.

I did not see any inclination on the part of the Commissioners to compromise on this bill, but they were anxious to make a fair and practical solution. And through these various sessions I think they have come out with a bill that is a good one, and that is why we are for it.

Senator WILLIAMS. I think we will close on that high note. We appreciate your appearance here with your associates. Thank you.

(Mr. Day's prepared statement is as follows:)

STATEMENT OF JAMES E. DAY, PRESIDENT, MIDWEST STOCK EXCHANGE

My name is James E. Day. I am president of the Midwest Stock Exchange, located in Chicago, Ill. With me are Joseph N. Morency, Jr., legal counsel for the exchange, and John G. Weithers, secretary of the exchange.

Our exchange has 400 memberships outstanding; 310 of these being held by member organizations serving the public, and the balance by individuals who do not deal with the public but are on the floor of the exchange and function as specialists, brokers, and individual traders. Over 120 of these member firms serving the public are also members of the New York Stock Exchange and other exchanges. Our member firms maintain over 2,100 offices and are located in every State and some foreign countries.

We have over 500 issues available for trade. These are composed of approximately 100 issues for which we are the sole marketplace. The balance are issues with nationwide interest and are traded on two or more exchanges. Many of these larger issues were originally listed solely on our exchange, but today their primary market is on the New York Stock Exchange.

In 1962 our exchange dealt in over 40 million shares having an aggregate dollar value of well over 1 billion 500 million dollars. The buying and selling of these shares earned for our member firms commissions totaling some $17,800,000. We are fortunate in being the largest exchange outside of New York City.

In my position as president of the Midwest Stock Exchange I have attended numerous meetings in the past year with various members of the special study group, the staff of the Securities and Exchange Commission and then recently as a member of a special liaison committee with the Commissioners themselves. The proposed legislation which you now have under consideration has been discussed in great detail at these meetings. In turn, I have reviewed this legislation very carefully and thoroughly with our board of governors.

We realize that this bill broadens the powers of the Securities and Exchange Commission over our industry. Neverthless, we are satisfied that the proposed legislation is basically designed to fill existing gaps in investor protection.

We, as an exchange, are gratified that part of the proposals will eliminate the double standard on reporting and other public safeguards applicable to listed and unlisted companies. We have long felt that this double standard has been inequitable and unreasonable; but, most of all, we feel certain Congress always intended that full disclosure of material facts should be made to the investing public whether their funds be risked in listed or unlisted securities.

We were concerned in this regard as to total cost of administration under earlier drafts of this proposal. We are no longer so concerned since the Securities and Exchange Commission has obviously given cost serious consideration, and the bill now includes only issues with 750 shareholders for 2 years, with the announced intention to review administrative costs before dropping to 500. Furthermore, in the asset test of $1 million, they have eliminated literally hundreds of issues that, for all practical purposes, have exceedingly limited public investor interest. In our view, this thoughtful weighing of cost places the Commission in a position to administer this reporting on a reasonable, economical basis.

In our opinion, this is a good bill, and the need for it has been abundantly demonstrated. Therefore, we wish to go on record as being wholeheartedly in favor of this legislation, Senate bill 1642.

(Mr. Day later submitted the following letter:)

MIDWEST STOCK EXCHANGE,

Chicago, June 24, 1963.

Mr. MATTHEW HALE,

Committee on Banking and Currency,

New Senate Office Building, Washington, D.C.

DEAR MR. HALE: At the conclusion of the Senate committee hearings on bill S. 1642 on Friday, June 21, 1963, I mentioned to Senator Williams that we had made a survey of accounting and legal firms as to their opinion of increased costs to smaller and medium-size over-the-counter firms to meet the requirements of the proposed bill. I explained that we did not include it for the reason that Mr. Etherington of the American Stock Exchange who preceded us had so adequately covered the subject.

We were then asked to write and make part of the record the results of our survey, which are as follows: We checked with four outstanding legal organizations who, to our knowledge, handle the bulk of securities work for the city of Chicago and found them to be surprisingly uniform in their estimation of increased costs. The estimates were not to exceed 10 to 15 percent more than present legal fees. The accounting firms estimates were similar in percentage totals, running from 10 to 20 percent, based in their instance, however, on the assumption that the firms were now receiving annually a regular CPA audit.

Putting the two together, we found that dollarwise additional fees for the smaller firms should not run more than $1,500 to $2,000, except in the most unusual cases; and for many of the firms who were now using legal counsel for tax purposes and receiving regular CPA audits, as low as $500 more than they were now paying.

We can only conclude that the arguments that have been expressed about the tremendous increased cost to the smaller firm simply are not true.

Yours very truly,

JAMES E. DAY, President.

Senator WILLIAMS. As our last witness this morning, we have Mr. Albert H. LeShane, who is treasurer of Employers' Group Associates. Mr. LeShane, we welcome you.

STATEMENT OF ALBERT H. LeSHANE, TREASURER, EMPLOYERS' GROUP ASSOCIATES

Mr. LESHANE. Mr. Chairman, my name is Albert LeShane. I am treasurer of Employers' Group Associates. I have filed with the committee a written statement outlining the position of the Employers' Group Associates as respects Senate bill 1642. I would like at this time just to briefly review that statement.

Employers' Group Associates are a Massachusetts group voluntary association formed in 1928 under a declaration of trust. It has transferable shares, and they are traded over the counter.

It actually is an insurance holding company. It owns four insurance subsidiaries. With the exception of a few other small investments, its entire assets are involved with these four subsidiaries. Employers' Group Associates, therefore, is actually an insurance company operating its insurance business through subsidiaries.

It is my understanding that representatives of the insurance industry will present to this committee statements as to why the insurance industry should be excluded from the provisions of this bill.

Since I am not representing the industry here today, it is not my purpose to outline these reasons at all, although my brief or my statement to the committee does outline some of the reasons why Employers' Group Associates feel that the insurance business should be excluded from this bill.

My purpose in appearing here today is simply to ask that if it is decided to amend this bill to exclude insurance companies, that that amendment be so worded as to include a holding company such as Employers' Group. Not to do so, we feel, would put it at a competitive disadvantage.

That is all I have to say. I thank you very much for letting me appear here today.

Senator WILLIAMS. You are anticipating a proposed amendment that will be suggested by the president of the Association of Casualty & Surety Companies?

Mr. LESHANE. I think so.

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